Column: Learn from the UMPP shocks

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We are facing some very interesting challenges in the power sector. On one hand we have a huge power shortage. On the other, the lack of demand from distribution companies is forcing power-generation companies to operate at sub-optimum levels, with lower plant load factors (PLF). Full recovery of fixed charges of the power plants cant be made at a lower PLF, resulting in either losses for the entity or lower profitsand both dont augur well for the economy. The coal mining and supplier companies are not scaling up production, citing lack of demand from the generation companies. So, we have dissatisfied consumers, and unhappy power and coal companies. The slowing down of the economy, particularly the considerably eroded demand from the manufacturing sector, is adding to the power sectors scaled back performance. In the household consumers segment, 44% of the total households are still waiting to get on the grid. The rest have been on an indefinite wait for assured, reliable power at affordable rates. Why is the power scenario so disheartening Whats missing One answer would be, apart from the requisite transmission lines, India is missing a policy framework that is needed to improve the situation.

The power sector needs policy architecture that is stable, forward-looking and, at the same time, provides adequate incentives to all stakeholders. It has to be customer-friendly, yet incentivise producers to invest in the sector. We need clear, well-structured policy. We must try and factor in as many variables as possible in policymaking to avoid some eventual shocks, like the ones that affected the ultra-mega power projects (UMPPs).

The goal of having UMPPs was to get large-scale power generation plants at fixed locations with captive mines or coal supplies tied up from overseas mines. The bidding for the projects was done with fixed, level-adjusted tariff. Normally, in a power plant, the tariff is fixed on the basis of fixed and variable costs, fuel costs forming a large part of the latter. In the case of UMPPs, we did not consider the variable nature of fuel costs and froze both the fixed and variable costs, to set a fixed tariff. The coal-based plants which were importing the fuel were obviously subjected to vagaries of global market trends which determine the price of coal. This was an obvious risk they had to take for which the reward was factored in the profits that were assumed they will make. What was not considered here was that even if we could foresee all future events, not all trends could be monetised to set a fixed tariff. It would have been prudent to define at the point of bidding itself the risks the developer will have to take and the events considered beyond the ability of the corporate entity that the regulator will review. We artificially converted all costs into a fixed-cost model.

Public bidding for the projects was undertaken as a model for the creation of infrastructure in the country. The success of this, it was assumed, would attract the investments we need in India$1 trillion in the next 5 years for all infrastructure projects, with $520 billion coming from the private sector. Private and public equity, corporate debt from banks and financial institutions, all would come provided the large infra projects like UMPPs succeeded, not just in terms of rewarding the debt and equity holders but also inspiring confidence of larger investing community. Now, it seems that the lack of proper policy structure at the time of bidding has resulted in some of the UMPPs suffering losses, while some have not got implemented and others have failed to start operations.

In the interest of the larger issues involved, we must resolve this imbroglio carefully to avoid sending the wrong signals. A very critical part of the success of creating new infrastructure with private money will depend on the sanctity of contracts as well as investor confidence in the process. Its more than imperative to ensure the safeguarding of the consumers interest in the whole exercise as finally all this is aimed at benefiting them and they are the ones who will ensure the projects commercial viability by paying the user charges.

Its true that the bidders knew that they were treading on an uncertain path and thus had taken commercial decisions with attendant risks. Let the risks that were foreseeable and normal to such business be borne by the developers. However, for this, a clearly designed package in which the promoters absorb all the costs arising out of such factors is needed. Its very important from the points of view of the economy, lenders and consumers that power plants operate at full capacity. The regulator must ensure that the consumer interest is fully protected while guaranteeing the plants full capacity operation.

The Deepak Parekh committee (DPC) recommendations have been questioned by few states which hold pre-purchase agreements (PPAs) with the UMPPs. Their fears are understandable as they would be burdened with extra costs from purchase if pass-through provisions are not allowed by the respective SERCs.

CERC could also ensure that, in the future, any fall in global coal prices would also be passed on to consumers, thus not putting the burden of price correction solely on them. The DPC recommendations should not be applied to other UMPPs without closely examining the real issues. The Tata Mundra project seems to have suffered largely due to the lack of proactive participation by the government of India at the time when the Indonesian authorities introduced radical changes in their fuel export policies. Timely intervention by the government then could have very well avoided this.

Its time we learnt the right lessons from this unfortunate episode. Policy formulation must factor in all possible future surprises to the furthest extent possible. The government must involve experts to formulate and draft the bidding documents for such projects. The private sector also must do its homework better. Its job doesnt end with only bagging large multi-billion-dollar projects. Its not that PPPs mean all the risks are to the public account and profits credited to shareholders. We need huge investments from the private sector to create infrastructure in India. There is no other country in the world that would have invested trillions of dollars of non-public money in creating public goods like power, roads, etc, of this magnitude.

The corporate and the government must work together as partners. Initial hiccups like this could derail the entire process and could put our economy under serious stress. Let the handling of the UMPP issue be a new learning and help create a new policy regime to avoid such pitfalls in the future.